Friday, June 15, 2018

Russia keeps tight conditions, slows shift to neutral

Russia's central bank left its key monetary policy rate at 7.25 percent and said the planned shift toward a neutral policy stance needs to be slower and tighter monetary conditions would help limit any impact on inflation from tax increases and a slight rise in inflation expectations.
The Bank of Russia, which also maintained its rate in April after two cuts earlier this year, raised its inflation forecast slightly and now expects inflation of 3.5-4.0 percent in late 2018 and then rise for a short period to 4.-4.5 percent in 2019 before returning to the 4.0 percent target in early 2020.
This forecast compares with the bank's earlier forecast of 3-4 percent inflation late this year and then around 4.0 percent in 2019.
"In the future, the Bank of Russia will explore the necessity of key rate changes by assessing inflation risks, inflation dynamics and economic developments against the forecast," the bank said, striking a more neutral tone in its guidance.
A neutral monetary policy rate had been estimated to be between 6 and 7 percent but in April the central bank said this had shifted toward the upper bound of this range in light of a rise in Russia's risk premium and higher interest rates in advanced economies.
While Russia's inflation rate is currently low, the central bank is looking ahead to the impact of the government's planned increase of Value Added Tax (VAT) to 20 percent from 18 percent and the fall in the ruble's exchange rate in April following new U.S. sanctions.
"The balance of risks up to the end of 2019 has shifted towards pro inflationary risks," from higher taxes and the impact of higher interest rates in advanced economies that may affect the exchange rate and thus inflation.
Russia's inflation rate has been steady at 2.4 percent from March through May as higher oil prices was offset by a substantial decline in fruit and vegetable prices.
Higher oil prices along with a fall in the ruble's exchange rate in early April had led to a slight increase in inflation expectations and the planned tax changes would add about 1 percentage point to inflation, with some of the impact this year.
While economic growth in the first quarter was slightly below the bank's forecast, the central bank said there was a rebound in April, confirming that the slowdown in March was temporary.
The central bank retained its forecast for economic growth this year of 1.5 - 2.0 percent and in 2019 and 2020 growth should remain close to the same level. Russia's economy grew by an annual rate of 1.3 percent in the first quarter of this year, up from 0.9 percent in the previous quarter.
In early April the U.S. launched new sanctions against Russia that led to a fall in stocks and a 10 percent fall in the ruble's exchange rate.
The ruble has yet to recover this loss and was trading at 62.5 to the dollar today, largely unchanged since early April, and down 7.7 percent since the start of this year.

The Bank of Russia released the following statement:

"On 15 June 2018, the Bank of Russia Board of Directors decided to keep the key rate at 7.25% per annum.

The Bank of Russia has reviewed the inflation forecast upwards considering the planned increase of the value added tax in 2019. This measure will influence the next year consumer prices dynamics and may affect this year’s dynamics as well. The Bank of Russia forecasts annual inflation to be 3.5–4% in late 2018 and increase for a short-term period to 4–4.5% in 2019. The consumer price growth rate will return to 4% in early 2020.

The balance of risks up to the end of 2019 has shifted towards proinflationary risks. In making its key rate decisions the Bank of Russia will assess inflation risks, inflation dynamics and economic developments against the forecast.

In making its key rate decision, the Bank of Russia recognised the following factors.

Inflation dynamics. Annual inflation in general corresponds to the Bank of Russia’s expectations. In April and May, the annual consumer price growth rate remained at the March level totalling 2.4%.

Inflation for main consumer basket product groups showed mixed dynamics. On the one hand, amid growing global oil prices coupled with the increase in excises early this year, the prices of oil products in the domestic market saw a tangible rise. This factor was the key contributor to the growth of annual inflation for non-food goods up to 3.4% in May (vs 2.7% in April). The adopted decision to lower the excises for oil products from 1 June 2018 will help to slow down the price growth for this product group by the end of this year. On the other hand, fruit and vegetable prices saw a substantial decline, which led to the drop in annual food inflation to 0.4% in May (vs 1.1% in April). This is related to continuing high supply of food products.

Inflation expectations of households and businesses saw a slight increase, which is primarily related to higher petrol prices. The weakening of ruble exchange rate in April moderately affects the dynamics of inflation and inflation expectations. In the coming months, prices will continue to adapt to the established level of the exchange rate and prices of oil products.

According to the Bank of Russia estimates, planned tax revisions will make about a 1 percentage point contribution to inflation. Partially this effect may take place this year.

The Bank of Russia forecasts annual inflation to be 3.5–4% in late 2018 and increase for a short-term period to 4–4.5% in 2019. The consumer price growth rate will return to 4% in early 2020.

Monetary conditions are close to neutral. The Bank of Russia estimates that they are already causing almost no constraining impact on lending, demand and inflation dynamics. Monetary conditions are being formed, among other things, under the influence of earlier decisions to lower the key rate. At the same time, the conservative approach of banks to selecting borrowers encourages a gradual increase in credit without creating risks to price and financial stability. Deposits remain attractive for households at the current interest rate levels.

Taking into account the impact of the suggested fiscal measures on inflation and inflation expectations, the transition to neutral monetary policy needs to be slower. Keeping somewhat tight monetary conditions allows to limit the scale of secondary effects arising from the tax policy decisions and stabilise annual inflation close to 4%.

Economic activity. 2018 Q1 annual GDP growth was slightly below the March forecast, totalling 1.3%. This resulted from a slower than expected growth of fixed capital investment, including a decline in construction, together with the review of the data for 2017 by Rosstat. April saw improved investment and industrial activity, confirming the temporary nature of slower economic growth in March 2018. In view of this, the Bank of Russia kept unchanged its 2018 annual GDP growth forecast of 1.5–2%, which is in line with the potential economic growth rate. In 2019–2020, economic growth will stay close to the said figure. The Bank of Russia’s forecast might be further updated to reflect a detailed estimate of influence that the set of fiscal measures, announced on 14 June 2018, will have on economic performance. The risk of some slowdown of economic activity persists in 2019. Although in the medium term if the scheduled measures are successfully implemented the expected economic growth could be faster compared to the Bank of Russia’s baseline forecast*.

Inflation risks. The balance of risks up to the end of 2019 has shifted towards proinflationary risks. The main risks are related to the effects of the adopted tax and fiscal policy decisions and to external factors.

With regard to tax policy measures the Bank of Russia will pay special attention to the estimation of secondary effects (including the response of inflation expectations), which are difficult to capture at the moment.

With respect to external conditions accelerated yield growth in advanced economies and geopolitical factors may cause surges in volatility in financial markets and affect expectations for the exchange rate and inflation.

The Bank of Russia leaves mostly unchanged its estimates of risks associated with consumer and oil price volatility, wage movements and possible changes in consumer behaviour. These risks remain moderate.

In the future, the Bank of Russia will explore the necessity of key rate changes by assessing inflation risks, inflation dynamics and economic developments against the forecast.

The Bank of Russia Board of Directors will hold its next rate review meeting on 27 July 2018. The Board decision press release is to be published at 13:30 Moscow time.